Star survivor: Applied Materials
If you want to see how it’s done, take a look at Applied Materials (AMAT, news, msgs), a long-time champ at exploiting the down part of the cycle. I’d argue that this company’s extraordinary success in the very cyclical semiconductor equipment industry is based on a strategy of being prepared to take advantage of the inevitable downturn.
For example, look at what happened to the research, development and engineering budget at Applied Materials as sales went into the tank in fiscal 2001, dropping to $7.3 billion in 2001 from $9.6 billion in 2000. Instead of slashing R&D, the company actually hiked spending to $1.2 billion in 2001 from $1.1 billion in 2000.
Where did the money go? Some went into playing catch-up in the copper interconnect market. Applied Materials controls 80% to 85% of the aluminum interconnect market but is weaker in the new copper technologies. Similarly the company invested in the tools market to match a new competitor, Novellus Systems (NVLS, news, msgs) that was threatening to take market share.
Some of the money went toward developing products designed to bury smaller or less deep-pocketed competitors. With the semiconductor industry working frenetically to get new 0.13 micron equipment up to speed, Applied Materials upped its spending on even smaller, next generation 0.10 micron gear. That spending should give Applied Materials the ability to dominate the next generation of equipment for squeezing more circuits on a chip just as past spending gave the company the current lead in equipment to process larger, more cost-effective 300mm silicon wafers.
So on past and current track record, I’m giving Applied Materials membership in my bubble survivor club. The company has met the test of the down cycle again, I believe.
But Applied Materials is an easy pick. The company is famous among investors for its aggressive down-cycle strategy, and it has pursued this course through enough similar down cycles in the past so that investors know it works. Now onto the hard choices: companies with less experience, and less of a track record, at making hay while it rains buckets.
Three other standouts
Adobe Systems (ADBE, news, msgs): Adobe has held together better than any other tech stock I can think of in this sector. Shares were down 47% in 2001 but rebounded 30% in 2002. Much of that is in anticipation of Adobe’s next big product cycle -- the rollout of Photoshop 7.0. Somewhere between 3 million and 4 million customers use Photoshop, and the software accounts for more than 25% of Adobe’s revenue, so this upgrade isn’t small potatoes. Every 1 million upgrades by existing users added $100 million in revenue for Adobe, and every 100,000 new users nets $55 million, UBS Warburg estimates.
But sweet as this upgrade cycle is, it’s business as usual. What earns Adobe a place on my rainy-day list is the company’s slow attack on the high-end page layout market currently dominated by QuarkXPress. InDesign 2.0, Adobe’s latest product for this market, has been shipping since mid-January and seems capable of winning significant share away from QuarkXpress, something that InDesign 1.0 simply wasn’t good enough to do. Adobe could have easily walked away from this product and market given the times, but instead it kept the pressure on its smaller and more stressed competitors. JP Morgan H&Q estimates that InDesign will add $150 million in annual sales for Adobe in three years.
Mercury Interactive (MERQ, news, msgs). This isn’t the easiest time to be selling software to corporate information technology officers, but Mercury Interactive has found a compelling sales argument: Its performance testing and tuning software for data networks improves performance and lowers costs. The company is pushing that sales pitch as hard as it can to cash-strapped enterprise customers. In the quarter that ended in March, the company’s core testing business grew 20%, indicating it is gaining share. Not content with that bit of success, the company has launched new products that automate performance testing and tuning in networks, just making its cost-cutting argument that much more compelling.
Mercury Interactive, which has managed to stay profitable through the downturn, isn’t above making a further pitch -- they’ll be around tomorrow to manage your network, the company notes, and who can tell where competitors will be? The company finished the March quarter with $590 million in cash and cash equivalents and retired part of its convertible debt.
RF Micro Devices (RFMD, news, msgs). The company has picked up share in the key power amplifier market (now above 30%, the company estimates), launched a major new product line (wireless LAN revenues are now 3% of total company sales), and increased margins by better than 2 percentage points in the last quarter. Oh, the company also is moving two of its manufacturing lines to larger 6-inch wafers to lower costs. The company was profitable in the March quarter and ended the period with $344 million in cash and cash equivalents, offsetting $300 million in long-term debt. This stock, however, needs some good news from wireless handset makers to provide a near-term catalyst.
Two newcomers
And now for my two new Fantastic 50 stocks to replace Enron and AtHome.
GlobespanVirata (GSPN, news, msgs). This company is doing everything right in the downturn -- although you’d never know it from the stock price. Shares have plunged 57% for the year -- that’s actually an improvement on the stock’s 62% dive in the last month. And that follows a 53% drop in 2001. But the late 2001 acquisition of competitor Virata has created a DSL (digital subscriber line) powerhouse.
The combined company owns 35% to 40% of the chip market for carrier central office gear and 25% to 30% of the customer premise market, according to Friedman Billings Ramsey. And GlobespanVirata looks likely to gain share thanks to continuing investment in new products like a chipset capable of aggregating up to 96 ports in a single platform. Long-term debt is a manageable $130 million and the company has $620 million, or about $4.25 a share, in cash and cash equivalents. That’s especially impressive since the company projects that it will be profitable in the third and fourth quarters of 2002. Now if only the moribund market for DSL gear would show some signs of life.
Xilinx (XLNX, news, msgs). If I were running a Xilinx competitor, I’d have said “Enough already” quite a while ago. According to Gartner Dataquest, Xilinx picked up 6 percentage points of market share in 2001, and the company is on track to become larger than all other programmable logic chip companies combined sometime this year, according to Michael Murphy, editor of the California Technology Stock Letter. With the knew Virtex II family of chips just now sampling with customers I don’t see the product onslaught letting up anytime soon. Xilinx generated $180 million in cash from operations in the March quarter and brought its cash and cash equivalents up to $510 million at the end of the period.
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